NOVATEK’s subsidiary company Arctic LNG-1 won an auction for the right to explore and produce hydrocarbons in the subsoil area of the Gydan Peninsula of the coast of the Kara Sea in northern Siberia. The acquisition will help NOVATEK secure its foothold in the Russian LNG market, as the Gydan Peninsula license will boost the resource base for large-scale LNG projects in the Yamal region.

The company bought the rights in an auction for $38 million (2.262 billion rubles) for a 27-year lease.

The Gydan site is located in close proximity to the Utrenno field, which is the resource base of Novatek’s Arctic LNG-2 project. The area is estimated to have a total resource potential of 4.74 billion barrels of oil equivalent. Together, the Gydan and Yamal peninsulas are comparable to LNG production in Qatar, NOVATEK has said.

The Arctic LNG 2 project will nearly match Yamal’s production capacity of 16.5 million tons (21 billion cubic meters) per year once it begins operating in 2022-2023. The plant will draw from a resource base of 1.2 trillion cubic meters of proven gas reserves in addition to 50.5 million tons of liquid hydrocarbons.

The addition of Arctic LNG 2 to the Yamal LNG project will significantly reduce the cost of producing LNG in Russia’s Arctic seas, and a liquefaction hub will be set up in Murmansk. Arctic LNG 2 is planned to cost $10 billion and produce 16.5 million tons (21 billion cubic meters) per year once it is in operation starting in 2022 or 2023.

NOVATEK CEO Leonid Mikhelson has said that Russia will soon occupy a quarter of the global LNG market, since the country’s share in world gas reserves is 22-24%. According to Mikhelson, Russia’s vast reserves give the country and obvious competitive advantage in the emerging LNG market.

By the end of this year, NOVATEK’s Yamal LNG project will be commissioned, and eventually production will reach 16.5 million tons per year.

According to NOVATEK, the company already has a significant raw material base on the Gydan Peninsula, including the Utrennoye, Geophysical and Ladderoyskoye fields, as well as the Trekhbogorny, Niavayakhsky, Zapadno-Solpatinsky, Tanamsky, and Severo-Tanamsky fields.

Thierry Bros, a senior research fellow of The Oxford Institute for Energy Studies sat down with Neftianka to discuss Russia’s future prospects in the LNG market.

Neftianka: You’ve been an analyst on both Russia and LNG markets for decades. You tell us, is LNG Russia’s top energy priority right now?

Bros: The government wants to be a decent player in the LNG world, and again, if you are the government, you have to address the question if you want to be a major LNG player, and ten years later you are a small player, but nowhere near where you wanted to be. It is difficult and risky for companies, therefore we need to partner one way or another.

Today we are in a world where there is too much LNG, other sources are drastically changing merit order system. The Russian government needs to answer one very simple question, is LNG strategic or not? It will need to adapt model to produce. If it decides that the project isn’t strategic, then the market can do it.

We are seeing a relaxed LNG world. I think companies have to think that its still a capitalist world, so you have to think about what type of strategy you want. If you have depletion of historical fields, then you need to find new fields.

You’ve been in the analyst trenches for quite some time now. What do you think about the current slump in LNG prices? Will Russia be able to influence LNG pricing the same way they were able to play with European gas pricing?

I think the Russian state will never be able to control the LNG price, it will be like Brent for oil. The question is, “Do we have sufficient market power LNG to understand the mechanics?” And right now the answer is no. The way to better understand the mechanics is to do more projects.

In order to better understand the LNG market, this means more Russian players and better reporting to the government. In a world where pipeline gas is going to be connected with LNG, Russia has an interest in understanding, but not necessarily controlling, the mechanics of LNG.

There is a very simple question if you are Russia is pipeline gas at discount to LNG, and if so, how can I price this?

The LNG “success” story that everyone is talking about these days is Yamal, an LNG plant with16.5 mtpa that looks like it can break even at $30/barrel prices, even though the area is remote and the technology advanced.

Novatek succeeded in understanding, thanks to Total [partner in Yamal LNG] that costs and CAPEX can’t go through the roof. They understood making it profitable from day one. We can’t twist the spreadsheet, the only way for this to go ahead is for the Russian government to take control, to provide tax holidays, port infrastructure, etc. Novatek and the Russian government definitely came out with a win/win situation.

Yamal has strong state support, provide LNG on time and on budget, a new thing in the LNG world these days. Russian LNG provided by different actors. Remember no monopoly in LNG world. Not enough to put Russia on the LNG map. Still second class player when it comes to LNG. Policy makers would like LNG to become more relevant in Russia.

Conversely, the Shtokman LNG project was thought to be risky, and was postponed. You cant say on your spread sheet you’ll add it up later, it has to be adapted from day one.

Gazprom’s Sakhalin, Russia’s first LNG project, had problems in term of CAPEX during the building phase, but now it operates perfectly fine.

We’ve seen LNG projects on maps for many years, but so far there are only two in Russia [Sakhalin and Yamal].

And what about Gazprom’s Vladivostok LNG project that has been officially shelved since late 2015?

If you are Gazprom, it makes sense to expanding Sakhalin because its cheaper.

Gazprom has never built an LNG liquefaction plant [their partner on the project, Shell, was the operator up until 2009].

Gazprom is extremely good at pipes and conventional upstream. LNG is challenging for them. I think Vladivostok LNG was on the map back many years ago because it was a hedge to Power of Siberia, but with Power of Siberia going ahead, they don’t need

Vladivostok LNG would in theory involve an undersea pipeline from Sakhalin to Vladivostok. Is it really profitable to use pipelines in an LNG project?

Gazprom is used to doing pipelines. They can do the profitability analysis and decide yes or no.

How do energy companies become more vertically integrated? What’s Gazprom’s future in an LNG world?

These big companies have the challenge to adapt – Exxon has the same problem with oil: Their mantra will be “oil, oil, oil” for how long? Gazprom has an advantage as a gas company, its one step ahead in the energy transition. This is why Rosneft is so pushy in breaking into the gas market. Gazprom understands there is a huge risk of unbundling, and for it to try and avoid it, in needs to be profitable day in and day out.

If you are Gazprom, you have to make your case stronger, and that means delivering what the state is expecting.

Gazprom will have a duty to do LNG projects in Russia. If your shareholders ask you do to something that isn’t profitable, you can come back and negotiate.

Of course it is easier to do in Europe, because Gazprom has a long history there, and Asians are tough bargainers. And when we compare this move to what’s going on in Europe, we see it’s a good for Gazprom. They are going to have a tendency to move towards Asia due to financing, sanctions, etc.

Will the Russian government support future LNG projects? How does this change with the 2013 law to “liberalize” the market, letting in new players Novatek and Rosneft to export abroad?

My understanding is that the Russia is creating competition between two national companies, Rosneft and Gazprom, and now Novatek.

It could be a good start. If you want liberalization of markets, this may be a good tool to use later on to move away from regulatory price. If you want to have a price of Russia that is reflective of the market.

Interestingly enough, the Russian government has opened the market to all the companies, and since this law, only one project. Did I pass a law for only one project, or am I going to tell the other companies that its time to deliver?

OK, last question. Do you think that St. Petersburg has the potential to be an LNG pricing hub?

Right now it is for a few players, but you have to start somewhere. You can use a hub as a pricing tool.

Russia’s ambitious Yamal LNG project in the Arctic is nearly two-thirds finished, Total’s Senior Vice President of Exploration & Production for Continental Europe and Central Asia Michael Borrell said. According to the top manager, 63% of construction will have been completed by the end of August (76% marks the first stage of readiness). The project is on schedule to open in 2017.

Borrell was speaking at the Offshore Northern Seas conference in Stavanger, Norway, which opened on August 29.

Once finished, the $27 billion Yamal LNG project will have a capacity of 16.5 million tons per year, which has been contracted to supply Asia and Europe (already 96% of liquefied natural gas has been contracted under the Yamal LNG framework). According to Borrell, a lot of that gas will supply European markets.

The project involves the construction of three LNG production lines. From the Tambeyskoye field, which has proven and probable reserves that were appraised at 926 billion cubic meters of natural gas in 2014.

To date, shareholders have managed to secure $18.4 billion in investment. According to the French gas major, $12 billion was provided by Chinese banks, $4 billion is sourced from Russian banks, and $2.4 billion is from Russia’s National Welfare Fund. Negotiations on raising more funds from Asian and Russian banks are underway. All tranches must be paid in rubles, euros, or yuan, due to the financial sanctions imposed on Russia by the United States.

Yamal is Russia’s first foray into Arctic LNG. Novatek, Russia’s second-largest natural gas producer, owns a 50.1% share in the project, along with Total (20%), China’s CNPC (20%), and the Silk Road Fund (9.9%).

To date, 57 out of 58 wells have been drilled as part of the first stage of the project. More than 17,000 people are currently working at the construction site, and an additional 24,000 are constructing equipment for a Chinese shipyard project